Much attention will be given to Mr. Greenspan's speech today and thanks to Bear Stearns, many market participants will be looking for a rate cut. If the market doesn't get one things could get dicey. Currently, equity futures are higher with S&P 500 futures edging up 1 point, NASDAQ futures are higher by 17 points and Dow futures are bid up 22 points. Fair value for the S&P 500 today is $2.56 and buy programs are set at $4.32 and sell programs are set at $0.67.
Using supply/demand and retracement to assess risk
Often times I get e-mail regarding the use of supply/demand charts and comments on the difficulty of understanding retracement levels. I've shown traders several techniques on the use of retracement brackets, but perhaps this will help many subscribers understand in essence what market makers are facing currently. If you can put yourself in a market makers shoes, you can perhaps understand the upside that currently presents itself, but more importantly the downside that a market makers is currently trying to manage.
NASDAQ Composite Supply/Demand Chart (COMPX) - $50 box
On February 5th, the NASDAQ Composite gave a supply/demand sell signal when it traded at 2,650 (the red 2 on the above chart marks a point in early February, the second month of the calendar year). Once a column of O's had been reversed into X's (O's from 2,800-2,400) we could then calculate a bearish vertical count and price objective for this index. The result was 1,900. If we believe this index could trade to those levels, we might then turn to a bar chart and use a retracement bracket that closely resembles the recent highs near 2,850 to our bearish price objective of 1,900 to help us understand the "levels" market makers may be using. Remember that market makers aren't trading the NASDAQ Composite, but all of the stocks they make markets for are traded on this index. You can get free supply/demand charts at www.stockcharts.com.
NASDAQ Composite (COMPX) Chart - 60-minute chart
One problem traders are currently dealing with is a market that is trading at "historic lows." This market condition makes it very tough to use "conventional retracement techniques" whereby the trader has attached the bottom of his/her retracement bracket to the low end of a trading range and attached the top of the bracket to the top end of a trading range. If we tried doing that with the NASDAQ Composite the past 10 months, we would have been redrawing retracement brackets on a weekly basis. The above retracement bracket still presents this "problem" currently, but the recent activity in the NASDAQ is perhaps better understood. Using the recent high of 2,892 (remember the supply demand chart highs just before the "sell signal" at 2,850) traders could anchor the "top" of their retracement bracket and then attach the bottom of the bracket to the bearish price objective (from supply/demand chart) at 1,900. This would be a more "conventional" way to use the retracement bracket. MAKE NOTE, that I didn't do any "fitting" at the 38.2%, 50% or 61.8% levels, but we are seeing some correlation in the chart. Could it be that market makers are actually using this tool and levels to help control their risk in their everyday market making activities? The "blue correlation" points might have been where a market maker was forced to buy stocks and provide a liquid market for investors that wanted out of stocks. The "red correlation" points might have been where the market maker then became a more aggressive seller to perhaps offset his/her inventories the he/she had to buy earlier and perhaps have to buy again. Remember that a market maker MUST PROVIDE A LIQUID MARKET IN STOCKS HE/SHE MAKES A MARKET IN!
How does this help me?
If traders are going to continue to trade many NASDAQ stocks, they must do just that! Trade them. I don't think market makers are going to let the NASDAQ just fall to 1,900 (if it falls at all from current levels), but they're not going to be stepping up with big bids until we start seeing some economic data to support such an action. Traders can see from the above chart that there are no levels of support other than the recent low of 2,156. Perhaps this also drives home the technique we've been using regarding retracement by attaching the upper end of the retracement bracket to a recent high and then "fitting" the 38.2% retracement level to an area of trading that looks to have had some significance. Subscribers can go back to the archive section for 02/20/2001 at 03:30 for a quick refresher.